Welcome to another quick 5 minute guide to understand the compound protocol. If you’re into crypto, chances are you’ve heard about it. That’s great! if not here’s your opportunity to learn what compound is all about.
Compound is simply a tool for people to get money (borrowing) and to give it to others (lending). It’s that simple. Now there are some key aspects that make this project one of the most interesting ones in crypto right now…
It’s the biggest DeFi project. DeFi means Decentralized Finance and it’s a group of new projects focused on bringing traditional finance tools like compounding loans into crypto, in a decentralized way.
They have what’s called a Liquidity Pool which is simply a Smart Contract where all the money is stored. A single place to borrow money from. Traditionally in most decentralized banking apps, you have to make a loan to a borrower directly, peer-to-peer.
With Compound, they have a single place with all the money and people access it as they need. So if you want to borrow say, 10 ETH you can do that from the pool. Of course, you always have to have a collateral.
A collateral is some token like ETH that you provide to the liquidity pool for others to use. For instance, let’s say I want to setup as collateral 100 DAI. That money will be available to borrowers. So if someone needs 40 DAI, the Smart Contract will extract that from the pool.
You can then use that collateral to borrow some other currency. For instance, let’s say you lock 200 ETH as collateral. You are then allowed to use the 75% of that ETH to borrow other assets. If the 75% of 200 ETH is about 10,000 dollars, then you’ll be able to get 10,000 USDT or DAI or the equivalent for other tokens.
That’s essentially how you’re able to borrow and lend in a decentralized manner. This is also known as the crypto loan but decentralized.
Note that your collateral will be sold if the price of that currency drops in value. Imagine ETH dropping a 50% in a few days. Your locked ETH will not be worth as much. So the protocol will detect that…